PLUS Loans Take the Lid Off Tuition Prices

The Negatives of PLUS Loans

A consensus is growing that federal student aid, however well-intentioned, is directly responsible for increases in college tuition over the past few decades. One study estimates that expansions of federal student aid roughly doubled tuition costs relative to a baseline, while another finds that each dollar of subsidized Stafford student loans boost tuition by 65 cents. The logic is simple: when students have access to a generous line of credit, colleges will raise their prices because their students can easily borrow the money to pay them.

In theory, since there is a cap on how much students may borrow through the Stafford student loan program (the most common form of student loan), there should be an upper limit to how much federal student aid can fuel tuition increases. Currently, the aggregate cap stands at $31,000 for undergraduate dependent students. But as the cost of college approaches this cap, more and more borrowers may take advantage of a back door — the Parent Loans for Undergraduate Students (PLUS) program.

PLUS loans are loans which the federal government makes to the parents of dependent undergraduate students to finance the students’ tuition. (Independent graduate students are also eligible.) They carry a higher interest rate (6.8 percent) than Stafford loans, which have a rate of 4.3 percent for undergraduates. Parents are eligible if they or an “endorser” can pass a basic credit check. Most importantly, there is effectively no credit limit — parents may borrow up to their student’s cost of attendance.

A cap on federal student aid is a reliable, if crude, way to slow tuition increases at institutions of higher learning. But this cap will be ineffective as long as the PLUS program exists. If dependent students hit the cap on Stafford loans, they can use the parent PLUS backdoor — and colleges will be more than happy to show them the way.

This is already occurring. Since the 1995-96 school year, the number of borrowers on the parent PLUS program has more than doubled to 716,000. The total amount disbursed has more than tripled in real terms, to almost $11 billion. While the average loan disbursement per borrower has remained roughly constant for Stafford loans, it has soared for PLUS loans — 60 percent since 1995. When policymakers place no limit on a taxpayer-funded line of credit, they should not be surprised at the result.

As average tuition rises, more students reach the cap on Stafford borrowing, and more must take out PLUS loans. In 1995, 12 percent of total federal loans for undergraduate study were made under the PLUS program, compared to 17 percent today. The rate of PLUS borrowing is highly sensitive to the Stafford loan cap.

In 2007, Congress raised the cap on Stafford loans for dependent students by roughly 30 percent. The share of undergraduate disbursements under the PLUS program fell from 21 percent in 2007 to 13 percent in 2010. It is rising again, as inflation erodes the value of the Stafford cap.

Aside from increasing the cost of college, PLUS loans have other distortionary effects. The 6.8 percent interest rate is almost certainly below what might be offered on the private market, meaning PLUS loans function as a subsidy for higher education. While some subsidy might be optimal (higher education may have positive externalities), an unlimited one is not, and it impedes the development of well-functioning private markets.

Why? Middle- and upper-class parents of undergraduate students will easily pass a credit check and be able to obtain a PLUS loan, bypassing private lenders altogether. Poorer parents often will not. Few private lenders will take a chance on low-income students, even highly promising ones, without the ability to lend to wealthier students to balance out the risk.

Private financing arrangements can impose more accountability on colleges to raise graduation rates and help students onto more promising career paths. The existence of PLUS loans crowds out such arrangements. Moreover, many of the most promising frameworks for private finance, such as income-share agreements, still lack a legal and regulatory framework in which to operate.

While it may be politically infeasible to touch widely-used Stafford loans for the time being, Congress should act on PLUS loans while they still comprise a relatively small share of disbursements. Policymakers should put a cap on disbursements, if not eliminate the program entirely. Additionally, private financing options should be expanded — indeed, the rather limited set of current PLUS loan borrowers could be a useful test-drive for more universal private programs in the future.

However, absent student loan reform, expect to see more and more PLUS loans given out in the future. In time, this relatively obscure government program could become a greater government liability. All the while, tuition will go up and up.